Avoiding the Death Spiral

With: Scott Minerd, Guggenheim Partners Global CIO, Portfolio Manager, Litman Gregory Masters High Income Alternatives Fund

Date: November 14, 2019

Jack Chee: Let's talk about trade. Where are we with that, and how important is the deal obviously, if this actually –

Interestingly, I think you were actually in China, if memory serves, when the first tariff actually kicked in.

Scott Minerd: Right.

Jack: With some very significant investors. So you might have some insights from the Chinese perspective, as well.

Scott: Yes. One of our clients – at least one -- is a state-owned company. Literally, at the moment that the tariffs went into effect, our meeting began.

I opened up by saying, "I feel that I'm here at a very inauspicious moment." Dadada. It was really amazing. Here is this guy – a senior guy – from a state-owned industry, saying to me, "Scott, look. The Chinese and American people have a very long friendship. "

He went back to talk about the Boxer Rebellion and how we had the open-door policy, which basically stopped the partitioning of China. He even went as far as to say, "And you liberated us in 1945."

He goes, "The American people are wonderful people. We should be focusing. We appreciate them. We do see what the president is attempting to do."

Now remember, this guy is in a state-owned industry. He says, "And many of his points have validity. We are hopeful that by him acting this way, it will help accelerate some change and reform in our own economy."

Their perspective – at least then – was pretty positive. And I think that what we see in Hong Kong right now, whatever you think of what's happening there, the hope of those people living in Hong Kong is that the United States will step in and do something.

I'm not saying we should or we shouldn't. But you can see their perspective about America is very, very positive.

Jack: Yes. The markets have vacillated a lot based on the news on the day around a trade tweet.

What is the downside if this all falls apart?

Scott: All you have to do is go back to 1930 and look at Smoot-Hawley. That's the real death spiral. All of a sudden, the spreads we –

I think if we just stopped in place, we'd be fine. It's sub-optimal. It's lowering our living standards. It's lowering their living standards. It's chopped growth off.

Until we reverse it –

The one thing about a tariff – and people I think miss this point – if you raise a tariff, it'll reduce growth. Our estimate is, the tariffs are going to reduce growth by 50-to-75 basis points (bps) over a 12-month period. But once you get past that, the growth trajectory just starts from a lower base.

We just permanently lower the base until we reverse it. It's not like you get that hit again.

The problem, of course, is that if this turns into the Death Spiral where we decide we're going to impose tariffs on European automobiles and we get retaliatory tariffs from them. Or we decide we have to increase the pressure on China. That's the thing that would be hard.

I do believe the president is worried about getting reelected, and I do think he understands that there are certain parts of the country he needs to support him. I think he's likely to at least cool his jets for the next 12 months.

Audience: Short question. Given the impact of the strength of the USD and declining global growth, what influence or effect do you think those might have on domestic growth?

Scott: Well, clearly, it's a drag. The headwinds are strong. But I do believe that Europe's manufacturing is starting to bottom out and turn around. I think China ultimately has no choice. It has to keep the economy going.

They have a lot more levers to pull than we do. Their deficit is nowhere near the size of ours, relative to GDP (gross domestic product). They have much-faster nominal growth, which gives them more flexibility on the debt side. They really have yet to just wholesale cut rates and do what we'd normally do in a crisis.

I think all of those things will eventually happen. Of course, the yuan will go down if they do that. Obviously that's going to cause political issues for them with the United States.

The one thing I think we have going for us with China right now is they still care. When they get to the point where they don't care and they decide, "We're just going to go it with the rest of the world," that's when we're really going to be in trouble.

But for the time-being, I'm convinced that we at least have them at the table. Hopefully this won't end in what could turn into a really, really nasty scenario.

But I'm an optimist.